Felix Salmon is finally toning down on his call for mass strategic defaults. In his post, The Corporate Conscience, he quotes Justin Fox: The individuals who make up the electorate in the United States are, as Friedman described, beings of many facets — their actions and their views shaped by pecuniary self interest but also by values, beliefs, and loyalties that might conflict with that self interest. The ideal for-profit corporation, on the other hand, is out to do nothing but make as much money as it can “within the rules of the game.” It is supposed to behave in a fashion that for an individual would probably be described as psychopathic. And if corporations are allowed to play a decisive role in shaping the “rules of the game,” we have effectively put the inmates in control of the asylum…
If corporations are persons, they are — if they behave as Milton Friedman wanted them to — persons with mental and emotional impairments so severe that any decent judge would feel entirely justified in declaring them incompetent.
Felix adds: There’s a connection, here, to the increasingly conventional-wisdom argument that walking away from a mortgage is perfectly fine since the banks who lent the money in the first place wouldn’t hesitate to behave in exactly the same way. But if Justin is right, we’d have to be psychopaths to treat corporations as our role models in such matters.
Absolutely! So no more public calls for actions that don’t solve the problem, and only make it worse.
And a long as we’re talking about how individuals are different from corporations, I want to add this one more thing, which I believe is important to remember, especially for those individuals who may be thinking of doing a strategic default, and justifying themselves by pointing out how corporations do it all the time. And here it is-
Corporations have a distinct and separate existence of their own, BUT their credit is very much determined by the character and integrity of the people who run them.
I believe this explains, partly but not fully, why corporations are sometimes able to get away with strategic defaults. When a corporation does so, its standing with the over-all credit community takes a nosedive, and its chances of taking out loans in the future, let alone at favourable rates, drops drastically. An individual who does the same will experience much the same consequences.
However, the individual running the corporation often does not stay long enough to reap these consequences. Sometimes they retire with their golden parachutes, sometimes they’re pirated by other corporations looking for the deadbeat CEO to replicate his astounding returns to their own shareholders. Sometimes they’re appointed Treasury Secretaries, or sometimes they merely bow out after falling from grace. The corporation, in the meantime, gets a new CEO, or is bought out by Warren Buffet, Steve Jobs, or some other angel investor who is trusted by the market. Because of this new individual, the company may be able to get new credit again.
Meanwhile, Joe Deadbeat, who’s already blacklisted by the market because of his default, remains Joe Deadbeat, 10, 20 years from now, and the memory of what he did will remain on the banks’ records. He will likely never get credit on favourable terms ever again. And this is particularly true, if his default was a STRATEGIC DEFAULT.
So, what proves disastrous economically collectively will also prove economically ruinous individually. Now stop for a moment and let that stick.
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Why are we even encouraging strategic defaults?
UPDATE: I hoist this from comments, because this is a common sentiment for a lot of people. I want to post my answer here.
Humbug! The US banks wont have anyone to lend to if they shut out defaulters, that is until the job market recovers. Can anyone with a brain see how a long term self sustaining recovery can ever be achieved by government spending? It will never happen. People like that douchebag Robert Reich say that government spending is the answer. Face it-property values are going to fall so much and interest rates rise so much that no one will want to buy.
the only way your argument makes sense is if 10 million homes are destroyed AND a 10 yr moratorium on residential construction is done. Then, real estate would actually have value for owners to sweat to keep, and for banks to actually lend on. in 5 years, 200K homes 'might' fetch 40k, cash, cause thats what theyre really worth. Houses are simply a proxy for bonds and as interest rise, home values will crash. Banks will be happy to lend to defaulters cause at least they might be INTERESTED in buying!
My answer: You have strategic default confused with mortgage forgiveness. No bank will grant loans to any buyer who has already defaulted. But they may be coerced into providing renegotiation and/or principal forgiveness, to minimize the value destruction that you’re talking about. I had put forward other possible approaches in the previous posts that I listed (read them, that’s why I put the links here). Nonetheless, for the sake of those who don't click, here they are in verbatim.
• If the banks already see a default down the line, they should just take their losses and foreclose now (and eat their losses) rather than trying to squeeze every last penny from borrowers who have already lost their jobs.
• In the case of borrowers having no ability to pay the adjusted rates on their ARMM mortgages, but still have paying jobs, banks will need to be coerced to renegotiate. Here, nationalization seems to be the solution. A better way would probably be to impose a restructuring along the lines of rent-to-own, and there have been good discussions on this so far in other blogs.
• In the case of borrowers who have the ability to pay their mortgage and only want to walk away, or do a renegotiation, because they are now underwater, the stance should still be ‘a deal is a deal’.
What would happen to the financial system once everyone no longer has shame of default? More defaults leading to more underwater mortgages leading to more defaults, all the way down to financial armageddon. If defaults become at all common, it won’t be long before we forever say good-bye to any notion of providing credit to anyone. And not paying debts because banks didn’t do their jobs properly could be just one step away from not paying taxes because the government isn’t spending your tax money correctly. Is that next?
And if you’re doing this to spite the bankers, remember that they are made up of more people than those who sold and structured toxic mortgages. Most likely, those most culpable have already taken out most of their equity (via corporate tax-deductible bonuses) and are likely to even profit from something such as this happening (they can short all finance-related futures indexes, bringing down all institutions that are in some way inter-connected with the prime culprits.)
Don’t cut off your nose to spite your face. In this scenario you talk about ,the biggest losers are depositors (that may be you!) and other borrowers who have faithfully paid their loans. The solution is stronger bank regulation, not Armageddon.